4 Factors that Drive Money Market Yields

By Cytonn Investments / Published November 5, 2019 | 9:40 am

A money market fund is a special type of mutual fund that invest in money markets. These mutual funds are invested in cash or cash equivalent securities.

They are normally short-term with a maturity of less than 13 months. Unlike other markets, money market funds are more convenient due to their low initial investment and high liquidity potential.

A money market yield, on the other hand, is any interest rates earned from investing in securities with high liquidity and short-term maturities. Yield is calculated by multiplying the holding period yield by a 360-day bank year and dividing the amount by days to maturity.

The yields generated in a money market fund are normally higher than in other markets. These high yields are usually driven by the following factors:

Investments

Investors are usually paid back in the form of dividends. Money market funds channel portions of their earnings to investors. The initial amount of capital invested in a money market fund will determine the dividends that an investor will earn upon maturity. Just like bank deposit accounts, the higher the investment, the greater the benefits enjoyed during maturity.

Time taken to invest the money

Investing in a money market fund is pooling funds in short-term instruments that mature in less than a year. As a result, the risks involved are normally low compared to debt securities. However, when this period is extended, investors face a risk of losing some of their investments due to factors such as fluctuating interest rates and rising inflation. Therefore, the longer you loan the money, the greater the risk that you could lose all your savings.

Inflation

Inflation occurs when demand for goods and services increases leading to a surge in their prices. This is usually caused by a high circulation of money in the economy. It means people have extra cash to spend which in turn forces sellers to hike prices. Inflation greatly affects savings as money loses its value. When inflation hits when your money is invested in money market funds, the expected yields at the end will certainly lose some of its purchasing power. Saving a million in a money market fund may earn you an extra two hundred thousand during maturity but this money may have less buying power compared to your initial investment fund.

Interest rates

Interest rates keep on fluctuating and this consequently impacts on financial products. These interest rates change mainly due to measures taken by the government when trying to control inflation. Although mutual funds are hardly affected by the interest fluctuations mainly due to their diverse and short-term nature, all the returns received from these instruments are linked to the existing market interest rates. It is, therefore, safe to say that the returns received from money market funds are all dependent on interest rates.